Rental activity is passive activity by definition, so rental losses are considered passive losses, and passive losses can only be deducted against passive gains.
Non-Real Estate Professional
If the taxpayer is not a real estate professional, the unallowed loss, if any, is carried forward until it used or until the entire interest in the activity is disposed of in a fully taxable transaction.
In an individual tax return, to see why passive losses aren't being allowed, print Form 8582. Unallowed losses will be indicated in one of the worksheets on the second page.
If the taxpayer or their spouse actively participated in a passive rental real estate activity, a special allowance of up to $25,000 ($12,500 for married filing separate filers) is allowed. The special allowance is reduced by 50% of the amount of modified adjusted gross income that is more than $100,000 ($50,000 for married filing separate filing status). The special allowance is phased out completely if modified adjusted gross income is $150,000 or more ($75,000 or more for married filing separate filing status).
Real Estate Professional
Real estate losses by a real estate professional are not treated as passive and are allowed in full in the year of the loss. Per IRC section 469(c)(7)(B) a taxpayer is considered to be a real estate professional if both of the following are true:
- More than one-half of the personal services the taxpayer performs in trades or businesses during a taxable year are performed in real property trades or businesses in which the taxpayer materially participates.
- The taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.
In a tax return being filed jointly, at least one spouse must satisfy these requirements separately from the other spouse.
A taxpayer is deemed to be materially participating if they are involved in the operations of the activity on a basis that is (a) regular, (b) continuous, and (c) substantial. In determining whether the taxpayer meets the material participation test, the IRS will examine all the facts and circumstances of the taxpayer's involvement in the real estate activity.
Additionally, the material participation requirement needs to be met on each property unless the taxpayer has elected to aggregate all properties under one activity per IRC section 469(c)(7)(A). This election can be made in TaxSlayer Pro and filed with the tax return.
Additional Information:
IRS: Schedule E - Supplemental Income and Loss